Taxpayer Wins Thanks to Unpublished Court Decision: That Lumber Drying in the Kiln Just Looks Like Raw Materials

By: Erica Horn and Maddie Schueler

In Northland Custom Processing[1], the KBTA held the Department of Revenue was precluded from re-litigating an issue decided previously even though the opinion of the Court of Appeals was unpublished.  The case presented to the Court of Appeals, Northland Corp. v. Revenue Cabinet, No. 88-CA-27-S (Ky. App. 1988), was referred to as “Northland I”.  In Northland I the Department had denied Northland qualification for and refund claims related to purchases of energy that should have qualified as exempt from sales and use taxes pursuant to KRS § 139.480(3).  The “energy exemption” provides that purchases of energy or energy producing fuels used in manufacturing or processing that exceed 3% of the “cost of production” by is exempt from sales and use tax.  Generally, the calculation of “cost of production” includes direct costs related to raw materials.

The question in Northland I was whether the lumber used by Northland in a kiln-drying process was direct material that had to be included in the cost of production.  The Court of Appeals, affirming the KBTA and Franklin Circuit Court, held that lumber was not a direct material in the process as the operation produced heat, not lumber, and therefore, Northland had properly excluded the costs of the lumber in calculating its energy exemption and in applying for an energy direct pay authorization, which is necessary for claiming the exemption.

The Department argued that Northland I should not be applied because Louisville Edible Oil Products, Inc. v. Revenue Cabinet, 957 S.W.2d 272 (Ky. App. 1997) (“LEOP”) constituted a “major change” in the law since the Northland I decision.  The KBTA held that LEOP was not a major change that would bar the application of collateral estoppel in this case because the case did not involve the question of whether the lumber was a direct material cost.  Instead, the case held that all direct material costs, including raw materials, had to be included in the cost of production.  Whether the Department will appeal the Board’s decision is unknown at this time.